Is making U.S. banks foresee trouble more trouble than it's worth?

* U.S. accounting standards board addresses loan loss
reserves

* Proposed standard would inject more judgment into process

* Some fear result could be new temptation to manage
earnings

By Dena Aubin

NEW YORK, April 15 Forcing banks to anticipate
trouble in their loan portfolios by reserving more money on
their balance sheets for potential loan losses seems like a
no-brainer, especially after the 2007-2008 credit crisis that
shook world economies.

So why is the U.S. Financial Accounting Standards Board
(FASB) meeting criticism over a proposal to do just that?

One reason is a fear that banks could abuse a new standard,
proposed in December by FASB, by using increased loan loss
reserves to smooth out the profits they report to Wall Street.

"If I had to dream up a way to manage earnings, I think this
is probably as good as it gets," said Edward Trott, a former
member of FASB, which writes the standards for the United
States' Generally Accepted Accounting Principles (GAAP).

FASB is seeking comments on the proposal through May 31. Its
details may change. FASB has not set an implementation date.
Analysts said it would likely not be effective before 2015.

The FASB proposal would allow banks to use their own
forecasts of future loan losses, injecting more judgment and
bias into the process, said Jack Ciesielski, publisher of the
Analyst's Accounting Observer.

Banks in essence could stuff their balance sheets with extra
reserves and use them later to smooth earnings, he said.

"The question isn't so much will somebody do bad accounting
with this; somebody will," Ciesielski said.

"The question is, will it become widespread, accepted
practice to do the accounting badly?"

RESERVES CITED IN CREDIT CRISIS

FASB spokeswoman Christine Klimek said in a statement that
estimating credit losses involves judgment under any accounting
approach. The proposal is meant to fix delayed recognition of
credit losses, a problem during the crisis, she said.

Under current rules, banks set aside reserves when there are
already signs of a loss, a so-called "incurred-loss" approach.

The new "expected-loss" standard would require banks to look
ahead and reserve for expected losses when a loan is originated.

Defaults on loans and other debt battered banks worldwide
during the global financial crisis, and many institutions had to
be bailed out with government funds because they had not set
aside enough for the massive losses.

Since then banking regulators have proposed a host of
reforms to help banks better withstand financial shocks. For
details see.

Several regulators, including officials at the Treasury
Department and the Comptroller of the Currency, have urged
timelier reserves as one needed reform.

A better tactic would have been to require loans to be
marked at fair value, which already includes forward-looking
information, Trott said. Fair value, or "mark-to-market," is
based on prices in the capital markets, a more neutral number
than figures companies themselves come up with, he said.

Reserve calculations also will be difficult to audit because
they will include subjective future forecasts, Trott said.

FASB proposed fair value for loans in 2010 but backed away
after opposition from the banking industry. Under a new proposal
in February, most simple loans would still be marked at
historical cost.

RESERVES ATTRACT SEC SCRUTINY

The U.S. Securities and Exchange Commission has long
scrutinized companies that use excess reserves to massage
earnings. In addition to banks, many companies use reserves to
cover such losses as litigation and environmental costs.

The SEC declined comment on FASB's proposal.

Past efforts of regulators to curb earnings management has
led some banks to keep their reserves to a minimum, the American
Bankers Association, a banking industry lobbying group, said in
a January report on the FASB proposal.

The ABA said it supports a change from the strict incurred
loss standard for loans, though requiring forecasts too far into
the future would not be reliable.

A spokesman for the ABA could not be reached for comment.

FASB Chairman Leslie Seidman has estimated that the new
standard might force some banks to boost loan loss reserves by
as much as 50 percent.

Earnings also might be more volatile as banks adjust their
expenses each quarter for expected credit losses, Fitch analysts
said in a report last month.

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